- We are now long Brazilian equities in our Real-Time Positions signaling product and continue to believe Brazilian stocks are a buy on weakness with respect to the intermediate-term TREND duration.
- On our proprietary GIP factoring alone, Brazilian equities look almost as attractive as they did to us back in early MAY – particularly from a GROWTH perspective, where our models continue to point to a back-half ramp in real GDP. For a variety of factors, the risk of a material ramp in INFLATION over the intermediate term appears to be receding.
- Risks to our positioning include: a sharp-selloff in “risk assets” across the Global Macro universe, as asset prices realign with their fundamentals. Moreover, a sharp, policy-induced selloff in the BRL vs. the USD remains a risk, though also receding on the margin relative to our previous expectations.
Earlier this afternoon, Keith bought the iShares MSCI Brazil Index Fund in our Real-Time Positions signaling product. Though we haven’t published an official stance until late last week, we did frame up the bull/bear debate on Brazilian equities in our AUG 30 note titled: “CONSTERNATION IN BRAZIL” (8/30). To recap, our interpretation of the bull thesis was as follows:
- On our proprietary GIP factoring alone, Brazilian equities look almost as attractive as they did to us back in early MAY – particularly from a GROWTH perspective, where our models continue to point to a back-half ramp in real GDP.
- Needless to say, it remains to be seen whether or not the Brazilian government’s aggressive year-long stimulus efforts will provide the intended boost to growth without spurring a measured ramp in INFLATION.
To point #1, intermediate-term Brazil’s GIP outlook is among the healthiest across the dozens of countries we track from a Global Macro modeling perspective. Brazil, having gone through “the soup” earlier and more aggressively than many other economies in the current cycle, appears poised to be well out front leading any global growth acceleration over the intermediate term – albeit from small numbers – on the heels of one of the world’s most aggressive fiscal and monetary stimulus efforts in the YTD.
To point #2, we received world late last week that our initial fears of accelerating inflation over intermediate-term may have been overblown – at least from a reported standpoint (from our WEEKLY ASIA & LATIN AMERICA WRAP-UP):
- What Happened (9/19): Brazil’s government plans to change the CPI index to decrease the effect of its notorious indexation policies (price increases tied to price increases that beget future price increases). Moreover, Mantega did mention that the electricity cost reduction as well as the recent and pending tax cuts will help keep a lid on Brazilian CPI in 2013.
- Why This Matters: While it’s hard to take Mantega’s word on CPI at face value, we wouldn’t rule out them altering the way inflation is calculated to help the government achieve the government’s political goals (the US government has mastered this technique). While this is morally bad and has very dour unintended consequences from a long-term perspective, it would remove a fair amount of inflation risk over the immediate-to-intermediate term – which would keep the Brazilian central bank on hold, and, more importantly, the market’s POLICY expectations along with it. After at +19% melt-up from its YTD bottom on JUN 5, I’m getting constructive again on the Bovespa. Shame on me, as my interpretation of these fundamentals has likely been primed by the market reaction leading into and through QE. That being said however, Brazil’s GIP outlook (attached) looks fairly robust from a trend perspective, so that does provide incremental cover for continued gains in Brazilian equities. Brazilian stocks are now officially a buy on weakness from our purview. For more details on our internal bull/bear debate on this asset class, refer to our AUG 30 note titled, “CONSTERNATION IN BRAZIL”.
Additionally, it increasingly appears that QE3 was nearly priced in from an inflation expectations perspective, delivering little more than a 2-day pop in “risk assets”, including global commodities markets. To the extent the trend of lower long-term highs across key commodity prices continues, we’d expect to see continued dovish revisions to inflation expectations in Brazil.
Given our below-consensus outlook for global GROWTH with respect to the intermediate term, we do realize the inherent risks of being long the high-beta Brazilian stock market at the current juncture – particularly with its exposure to the Inflation Trade (69% of the Bovespa Index is Energy, Basic Materials and Financials stocks). That said, however, we’d be remiss to ignore the fact that during the Global Financial Crisis the Bovespa Index bottomed in OCT ’08 – well ahead of other global equity and commodity markets – as rapid, state-directed credit expansion helped mitigate the effects of the Great Recession upon the Brazilian economy. It’s worth noting that Brazil scores very well on our proprietary Stimulus Space Index (methodology here).
Another risk we see to being long Brazilian equities is BRL depreciation relative to the USD – particularly of the sharp, POLICY-induced variety. To this point, in an interview in London last week, Brazilian Finance Minister Guido Mantega reiterated his aggressive stance against QE3 and reminded investors that Brazil could implement possible measures such as raising cross-border IOF tax rates and politically pressuring the central bank to incrementally lower the benchmark SELIC interest rate, as well as have them accelerate reverse currency swaps – all with the intent of promoting a lower exchange rate amid what Mantega himself dubbed an international “Currency War”.
Again, it appears increasingly less likely that the USD puts on a sustained down move from here over the intermediate term as the Fed’s POLICY potency appears to be fast losing steam. While that does increase the likelihood we’d see BRL depreciation over that duration, a sharp, policy-induced selloff in the BRL vs. the USD like we saw earlier this year appears less likely.